Don't delay public input on Fed's review of capital requirements

Last month, Federal Reserve Vice Chair for Supervision Michael Barr outlined the Federal Reserve's agenda to make the financial system safer and fairer by improving banks' safety and soundness. Barr called for a holistic review of the bank capital framework, including a review of leverage and capital requirements for large banks. We welcome the Fed's review. And we urge the Fed to be more transparent about it. 

Mr. Barr is right. Currently, the U.S. capital framework is comprised of a dizzying array of moving parts: risk-weighted assets, stress capital buffers, surcharges on global systemically important banks, countercyclical buffers and leverage buffers, just to name a few.

Samuel Corum/Bloomberg

All these requirements are implemented separately, sometimes with several years between rules. No singular element of the capital regime determines overall capital requirements — rather, the various constraints knit together in complex and unpredictable ways to determine the overall amount of capital required of large banks.

Given that capital requirements strongly influence the cost and amount of lending by banks in our economy, getting the mix of requirements right is critical, as is transparency around this process. 

Right now, all we know is that the Fed expects to complete its review this fall, and will only seek public input on proposed capital rules that are informed by the findings of the review after it is complete. We don't know much about how the review is being conducted, but we do know it is happening quickly — and without public input.

But waiting for public input until so late in the game — once the direction of travel is set — is too late and risks consequential errors based on a lack of full information. The Federal Reserve should commit to seeking public feedback on its holistic review of the capital framework before the review is finalized and before any subsequent capital rules are proposed.

Public feedback is crucial for several reasons. 

First, regulators' analysis can be improved by taking input from a variety of stakeholders, including academics and practitioners with significant expertise in bank capital. 

Second, public input will help ensure an evenhanded approach in reviewing the capital framework. A review solely conducted by regulators runs the risk of tipping the scales in a direction confirming existing policy preferences, even if there may be data supporting other perspectives. 

For example, studies have found that central bank-sponsored research on quantitative easing's effectiveness is more positive than other research on the topic. A full, open review of the capital framework soliciting input from a wide array of stakeholders will help ensure a thorough, unbiased and informed assessment. 

Most important, any study of the capital framework either implicitly or explicitly embeds a value judgment about the appropriate trade-off between economic growth and financial stability. Regulators are charged with maintaining financial stability, but they are not solely in charge of determining how society balances safety versus growth. Finding the right balance between growth and stability requires weighing the costs and benefits of additional financial stability measures against the impact on job creation and living standards. That debate must be informed by the views of all relevant stakeholders.

The Federal Reserve and other agencies reviewing regulations routinely do so with public input. At least every 10 years, the bank regulatory agencies are required by federal law to gather public input and review existing regulations. During the last cycle, regulators traveled the country for in-person meetings and collected written feedback. At one of these meetings, Federal Reserve Board Chairman Jay Powell explained that creating balanced, effective and thoughtfully calibrated regulations to avoid undue burden requires input from stakeholders.

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Researchers' review of the capital framework should also adhere to existing transparency standards for published academic research — and all of the data and analysis should be made public. The economics literature is replete with examples of studies that came to drastically incorrect conclusions because of simple data errors that were later uncovered by other researchers. Most academic journals now require that the data and programs used to conduct any analysis be made public before the results are published. 

The stakes are too high to accept even a small probability of an errant mistake.

A comprehensive review of the capital framework and soliciting public input are necessary to ensure a safe and sound banking system in balance with the promotion of economic growth.

Doing one without the other will be counterproductive — and risks reaching an outcome that does not reflect the needs of our economy.